Prime RMBS Index Postponed, MarkIt Says

It was such a small press statement, but one imbued with indelible meaning — Markit, the financial technology firm that manages indices for the subprime and commercial mortgage securities markets, said earlier this week that it had postponed a planned launch of a new index tracking against prime RMBS. “Following extensive discussions with major market participants, plans to launch a synthetic U.S. prime mortgage-backed securities index have been put on hold,” the statement read. “The potential benefits of the proposed index will be re-assessed in 2009.” That’s it. But there is much more behind the words, when you consider that synthetic credit indices have been assailed this year by critics who say the derivatives trading powered by them helped push the financial markets to the brink of outright disaster in this past year. In the case of the subprime market, Markit’s ABX index was launched in 2006 to track the private-party subprime RMBS market — and it allowed some hedge funds an easy mechanism to short the market for subprime mortgages. We’ve covered the ABX here extensively at HousingWire in the past 12 months. See earlier coverage. Critics say that enabled a crash, while fund managers say they were simply using the industry’s first transparent tool to make bets on mortgages they knew were bad. “The derivatives trade here worked in both directions, it goes both ways,” said one trader that spoke with HW, but asked not to be identified. “Those saying we’re being too pessimistic can always trade with their optimism, if they felt inclined to do so.” TheStreet.com’s Dan Freed has much more on the delay at Markit, suggesting that the delay came as regulators expressed concerns about putting a “weapon of mass destruction” into play in the prime mortgage market. “Financial companies around the world … collectively hold trillions of dollars worth of prime mortgage securities on their books, but they have a great deal of latitude in how they price them,” Freed writes in the story. “A prime mortgage index would take away a lot of this latitude, as banks carrying mortgages on their books at a significantly higher price than the index would have a lot of explaining to do to their auditors. That could lead to new writedowns on a massive scale.” Market critics have suggested recently that the ABX has become a victim of a classic “macroeconomic short,” meaning that the value of the securities has been pushed well below their actual value based on default rates and expected cash-flows. At least one hedge fund, T2 Partners LLC, has come out publicly and said it is snapping up subprime RMBS wherever it can, based on this premise. Of course, only time will tell if the bet is well-timed or not — but the point here is that primary dealers are clearly worried about messing with the mechanics of a prime mortgage market that is already facing challenges of its own in recent weeks. And, compared to subprime, the prime securitized mortgage market is BIG one, too. The securitization rate for loans originated in the first three quarters of 2008 rose to 78 percent, up from 74 percent in the year-ago period and 61 percent in 2001, according to a Bloomberg report Friday morning that cited data from industry newsletter Inside MBS & ABS (no link available, yet). In other words: the originate-and-sell model is alive and well in prime markets, and establishing a synthetic index could provide leverage for exposure that no primary dealer is likely to be comfortable with. TheStreet.com’s Freed notes that there is no confirmation as of yet as to whether regulators are involved in the index or not. But here’s guessing that the rollout of this particular Markit index will meet much more scrutiny than its subprime cousin. Write to Paul Jackson at [email protected].